EMERGING RISKS: Uncertain times

Written by Deborah Ritchie

December 2016

Seismic shifts in risk scenario planning will be needed to address a multitude of emerging complexities throughout the coming year. Deborah Ritchie looks at some of the key issues

Challenges to globalisation and free trade highlighted by the US election and Brexit referendum usher in year of heightened strategic uncertainty on both sides of the pond. These two issues have become impossible to avoid, as the distinction for businesses between perceived safe domestic markets and foreign ones rife with challenges has become so marginal.

These are among the topics explored in Control Risks’ annual forecast for business risk professionals, whose CEO Richard Fenning says the unexpected US election and Brexit referendum results that caught the world by surprise will make 2017 “one of the most difficult years for business’ strategic decision making since the end of the Cold War”.

Fenning says the catalysts to international business – geopolitical stability, trade and investment liberalisation and democratisation – are facing erosion, making the commercial landscape among government, private sector and non-state actors ever more complex.

These high levels of complexity and uncertainty will force boards to undertake comprehensive reviews of their approaches to risk management. Control Risks identifies further major risk factors for consideration. “Terrorist attacks across continents in 2016 made possible in large part by the internet have shown that Islamist inspired violence can be planned and carried out anywhere in the world,” Fenning continues. “Digitisation and the Internet of [Things] take risk everywhere and the distinction between safe home markets and dangerous foreign ones has largely gone. The sheer mass of stored data, teetering on a fulcrum between asset and liability, has shifted the gravitational centre of risk.”

Expert view

For the risk experts at the Institute of Risk Management (IRM), it was political risk, cyber security, bribery and oil price and financial markets fluctuations that were found to be among their chief concerns. Chair of the IRM, Nicola Crawford, says in this environment, enterprise risk management has never been so crucial. “2017 is undoubtedly the year where political risk on the global scale will be one to watch. The effect on markets is unknown with the City of London and the wider stage braced for a hard Brexit and also the fall out of changes to American and European political leadership,” she says. The global economy continues to be a risk for a number of reasons including oil prices, Brexit, possible Grexit and a slowdown of the BRICS economies (Brazil, Russia, India, China and South Africa).

The Institute says that both a devalued pound as well as potential EU barriers to trade, could have a serious impact on manufacturers importing parts from abroad. “It’s not just British companies [that] may be at risk however, as any foreign companies selling goods in the UK may find the weak pound hitting their sales. This could lead to an increase of prices, having a negative effect on consumers in the UK or could even lead to companies pulling out of the UK and relocating to other parts of the EU,” it warns.

“Whilst there are many risks involved with Brexit, there will inevitably also be many opportunities. A weakened pound would increase exports and encourage British companies with foreign suppliers to innovate or seek local suppliers in order to reduce costs.”

Whilst oil companies have restructured their businesses in line with sub US$50 oil prices, the IRM warns that many countries that are reliant on oil as a major part of their GDP could face major economic crisis and social unrest. The economic as well as political impact could spill over into neighbouring countries and this could potentially have a detrimental effect on the global economy.

It’s not all doom and gloom in the Institute’s forecast, however. “Oil prices seem to have stabilised around the US$45-US$50 mark for the last six months and with oil companies having adapted to this new reality, any increase in the price will see major profits and investment in new projects,” the IRM says. “Even without an increase in price there is opportunity to be found, with oil companies already investing in renewable energy, they may invest even more heavily into it.

“Factors in both the micro and macro environment should be constantly scanned against a company’s risk register, business continuity plans tested and stress tests conducted. Reputational risk is also a major factor and examples of how not to manage this have been widely reported in the media,” she explains, adding that disruptive business models, the Internet of Things and the impact of a more connected world will all contribute to a new way of working.

Complex supply networks

The level of risk faced by global supply chains is moving rapidly upwards as we start the year, according to the Chartered Institute of Purchasing and Supply. The IRM’s Carolyn Williams says firms have long been conscious of the need to manage their supply chains to ensure continuity and efficiency, but that recent years have seen two specific shifts that significantly alter the landscape. “First the trends towards globalisation, outsourcing, offshoring and specialisation have introduced an additional degree of complexity and uncertainty to supply networks. And secondly, widespread adoption of social media and rapid means of communication mean that reputation is constantly exposed,” she explains. “One recent tweet by Donald Trump, questioning the cost of the US F-35 fighter jet project, knocked more than £4 billion in one day off the value of the three defence companies, including BAE Systems,” she adds. “Organisations are increasingly called to public account for their decision making, which includes the behaviour of those with whom they choose to do business, directly or indirectly. All organisations need to be alert to issues of supplier viability, robust contracts, disruption from natural catastrophes, fraud, bribery and corruption, slavery and working conditions.”

That said, the rising issue of corruption risk should not stop businesses from expanding into new territories as the rewards can be so great. As group CEO of The Risk Advisory Group, Bill Waite, points out, “High levels of corruption risk need not preclude a market from a company’s expansion plans for 2017. And indeed in certain industries the riskiest countries are often the most rewarding. The key to overcoming the challenges is to have a robust risk mitigation programme in place, based on adequate integrity due diligence.”

Litigation

An array of new risks including rising regulator and shareholder activism and the influence of third party litigation funders are putting corporate leaders under more pressure than ever of falling foul of investigations, fines or prosecution over alleged wrongdoing.

These are the conclusions drawn by Allianz Global Corporate & Specialty (AGCS) following analysis of its D&O claims. It found a growing trend towards punitive and personal legal action against executives for failure to follow regulations and standards which could result in costly investigations, criminal prosecutions or civil litigation.

“While the legal landscape differs strongly from country to country, increasing shareholder or regulatory action has become a global phenomenon that needs to be given top priority within companies’ internal risk management departments,” explains Bernard Poncin, global head of Financial Lines at AGCS.

According to AGCS, non-compliance with laws and regulations is now the top cause of D&O claims by number, followed by negligence and maladministration or lack of controls. The average D&O claim for breach of duty costs over US$1 million (€1 million), and for large corporate liability cases can be valued in the hundreds of millions of dollars. AGCS observes a general trend for D&O claims to be dismissed or resolved more slowly, meaning lengthier litigation, increased defence costs and higher settlement expectations. Illustrating the impact, the average US securities class action case takes between three and six years to complete while legal defence costs average around US$10 million, rising to US$100 million for the largest cases.

In the past six years defence costs have almost doubled for large D&O claims in the US. The influence of third party litigation funding is also changing the global litigation map, with it being pivotal in the development of collective actions against financial institutions and commercial entities and their directors and officers.
New corporate offences in the UK?

Speaking at the Cambridge International Symposium on Economic Crime in September, the Attorney General reiterated the Prime Minister’s priority of expanding economic opportunities – meaning businesses “of all sizes” should be better held accountable for their failures. The Attorney General also restated the intention to consult on extending the criminal offence of ‘failure to prevent’ to other economic crimes such as fraud and money laundering so that firms are properly held to account for criminal activity that takes place within them.

“If a new corporate offence of failing to prevent economic crime is introduced in the UK, it will represent a huge expansion in corporate criminal liability,” says Terry FitzGerald, head of Commercial D&O and Financial Institutions, UK at AGCS. “Although these particular reforms are focused on corporate liability, there is, of course, a broader drive to hold individuals accountable in the event of criminal conduct or regulatory breaches at their companies.

“In recent years, increasing emphasis has been placed on personal accountability across all business sectors, with Deferred Prosecution Agreements now a means to further increase cooperation with regulators and encourage best practice. Reform in this area could ultimately have a fundamental impact on the risks faced by senior executives.”

Allianz believes the risks and potential liabilities of senior executives have never been greater. In the US, the number of security class action filings is rising and, at mid-year, was on course for its highest annual total for 12 years.

Meanwhile, a number of Asian countries including Japan, Hong Kong, Thailand and Singapore are also moving towards a more litigious culture. An increase in claims has also been pronounced in Germany where the number of D&O claims for AGCS alone has tripled in the past 20 years.

The landscape for executives is further complicated by a number of other emerging perils, including liability around cyber attacks and data privacy. In the US, several class actions relating to data breaches have already been filed. Data protection rules around the world are becoming increasingly tough, with severe penalties for non-compliance. As a consequence, AGCS experts anticipate cyber security-related D&O litigation more widely in the US, but also in Europe, the Middle East and Australia.

Additional management risks on the horizon according to Allianz include negative disclosures or allegations around environmental pollution, climate change and modern slavery which could result in reputational risks and shareholder activism, public outcry or governmental action. Mergers and acquisitions also continue to be a key driver of D&O litigation, a trend that is expected to continue.

KEY BUSINESS RISKS FOR 2017 (Source: Control Risks)

Political populism exemplified by President-elect Trump and Brexit The era of greater national control of economic and security policy ushered in by the US election and Brexit provides increased uncertainty for business leaders. Caution prevails because of the lack of political policy clarity from the US and UK and the impacts on the global trading and economic environment, as well as geopolitics. Political sparks will fly as the new presidency places pressure on the economic relationship between the US and China, vital for the stability of the global economy; and the US withdrawal from the Trans-Pacific Partnership threatens to redraw Trans-Pacific commerce. The calls across Europe for further referendums on EU membership is causing nervousness and populism in other parts of the world such as sub-Saharan Africa is adding fuel to investor risk.

Persistent terrorist threats The threat of terrorism will remain high in 2017 but become more fragmented. The eventual collapse of Islamic State’s territorial control in Syria and Iraq will lead to an exodus of experienced militants across the world. Responding to terrorism is becoming ever more difficult for businesses; risk adjustment is critical, including big data solutions and reviews of potential insider radicalisation, physical security and scenario planning.

Increasing complexity of cyber security 2017 will see the rise of conflicting data legislation: US and EU data protection regulations remain at odds; the EU’s Single Digital Market is isolationist; and China and Russia are introducing new cyber security laws. This will lead to data nationalism, forcing companies to store data locally, at increased cost, as they are unable to meet regulatory requirements in international data transfer. Ecommerce will be stifled. Fears of terrorism and state sponsored cyber attacks will exacerbate national legislation, adding burden to businesses.

A potential brake on US regulation could lead to a transformation of the global regulatory environment. The US adherence to the Paris climate accords is under question, the Dodd-Frank Act could be modified substantially and the Foreign Corrupt Practices Act is not off limits, either. This could have a domino impact on regulation around the world.

Intensifying geopolitical pressures driven by nationalism, global power vacuums and proxy conflicts. Syria, Libya, Yemen and Ukraine are likely to remain intractable conflicts and the Middle East will continue to be shaped by friction between Saudi Arabia and Iran; China’s increased focus on diplomacy and military influence will extend from Central Asia and the Indian Ocean to sub-Saharan Africa; and North Korea’s systematic nuclear capability development is upending a relatively static regional and global nuclear status quo.

GLOBAL RISKS OVER THE COMING DECADE (Source: World Economic Forum)

Economic inequality, societal polarisation and intensifying environmental dangers are the top three trends that will shape global developments over the next 10 years, according to the 12th edition of the World Economic Forum’s ‘Global Risks Report’.

This major report, which each year features an assessment by experts on the top global risks in terms of likelihood and potential impact, found that trends such as rising income inequality and societal polarisation which triggered political change in 2016 could exacerbate global risks in 2017, if urgent action is not taken. The WEF warns that collaborative action by world leaders will be urgently needed to avert further hardship and volatility in the coming decade.

Rising income and wealth disparity and increasing polarisation of societies were ranked first and third, respectively, among the underlying trends that will determine global developments in the next ten years.

The most interconnected pairing of risks in this year’s survey is between high structural unemployment or underemployment and profound social instability.
The environment also continues to dominate the global risks landscape. Climate change was the number two underlying trend this year. And for the first time, all five environmental risks in the survey were ranked both high-risk and high-likelihood, with extreme weather events emerging as the single most prominent global risk.

The WEF’s extensive report into global risks also concluded that society is not keeping pace with technological change. Of the 12 emerging technologies examined in the report, experts found artificial intelligence and robotics to have the greatest potential benefits, but also the greatest potential negative effects and the greatest need for better and appropriate governance.

CORRUPTION DANGER SPOTS (Source: Risk Advisory Group)

Throughout the coming year, companies can expect to encounter more corruption challenges in Asia and in Africa than in any other region – and least in Europe. China is the country where businesses face the most potent combination of corruption risk and difficulty in obtaining a clear picture of the local business environment, followed by Iraq and Nigeria.

The Risk Advisory Group’s ‘Corruption Challenges Index’ ranks 181 countries using a number of measures, including the local threat of corruption; how exposed foreign investors are to corruption itself as well as to FCPA enforcement action; and the availability of reliable information to conduct integrity due diligence and mitigate the risk of dealing with corrupt parties. The rankings reflect the judgement of Risk Advisory’s analysts through their experience of helping organisations investigate and do business in those markets.

Enforcement actions under anti-bribery legislation such as the US Foreign and Corrupt Practices Act (FCPA) can greatly elevate the risk to businesses operating in a jurisdiction, and the high number of FCPA cases involving China is one of the main reasons for its top spot in the index. A censored press, and poor quality or hard to access public information were the other common features of the countries labelled as most challenging.

At the other end of the spectrum, Europe generally performs well in the index and dominates the list of least challenging countries. It makes its first appearance at number 28, with Greece, which although not assessed to have the highest risk of corruption in the region (that position is held by Bulgaria), presents significant challenges for foreign investors.

Highly fragmented corporate databases and a lack of reliable local investigative sources make the country an extremely problematic place to conduct due diligence investigations, particularly for non-native Greek speakers.

Industry sectors are also ranked, with construction and development, infrastructure, oil and gas emerging as the most challenging from a corruption point of view.

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